Japan drops interest rates to zero

Central bank cuts rates and pledges to buy some $60bn worth of assets in attempt to stimulate the country's economy.

Tue Oct 05 2010 09:58:52 GMT+0000

Slashing interest rates and purchasing 5 trillion Yen of assests will provide a much needed boost to the economy [EPA]

The Bank of Japan has cut interest rates to zero and pledged to buy $60bn worth of assets in an attempt to stimulate the world's third largest economy.

The central bank on Tuesday lowered its key rate to a range of between zero and 0.1 per cent in its first such move since it set the rate of 0.1 per cent at the height of the financial crisis in December 2008.

For months, the central bank had shunned government calls for more decisive action, such as buying more government bonds, and focused instead on a limited funding scheme.

But in the face of growing evidence that the yen's strength was hurting the economy, the Bank of Japan (BOJ) cut its overnight rate target and also said it would keep its benchmark rate effectively at zero until price stability was in sight.

Core consumer prices have been falling from a year earlier since early 2009. With the drop in interest rates, consumers will spend more and in turn begin pushing prices in the opposite direction.

Steps welcomed

The 5 trillion yen ($60bn) asset purchases, which would inject more cash into the economy, roughly matches the size of extra stimulus being considered by the cabinet.

The assets, ranging from government bonds and short-term government securities to commercial paper and corporate bonds, would come under a temporary scheme that would also cover 30 trillion yen of such assets as collateral under an existing loan programme.

"The BOJ is bringing its monetary policy closer to quantitative easing, allowing market rates to hover near zero and pledging to keep a near-zero interest rate policy in the longer term until prices stabilise," Naomi Hasegawa, an investment strategist, said.

BOJ policymakers have signalled in past weeks that they were considering a further easing of policy after Tokyo's intervention in the currency market in mid-September to check the yen's strength offered only temporary relief.

Most market players, however, had expected the central bank to opt for a relatively minor adjustment of its 30 trillion yen loan scheme that supplies banks with funds at its 0.1 percent rate.

"These steps are more aggressive than markets had expected. The BOJ's decision is a surprise and will have an impact on currencies due to the message it delivers," Hasegawa said.

Global effects

The surprise move weakened the yen against the dollar, pushed up Japanese government bond futures and helped stock prices turn positive.

Japan's Nikkei average bounced back to post its biggest daily percentage gain since mid-September, with shares jumping more than one percent, leading Asian equities higher.

Benchmark oil for November delivery was up 14 cents to $81.59 a barrel at late Tuesday afternoon Singapore time in electronic trading on the New York Mercantile Exchange.

"The oil price strength is very largely a response to the weaker dollar," said David Wech of JBC Energy.

Central banks in Japan, the United States and Britain have been under political pressure to do more to support economies showing only tepid recovery from the worst recession in decades.

In Japan, slowing export growth, a surprise fall in factory output and companies' worries that the strong yen may hurt the outlook have heightened the case for the central bank to ease policy.